New lawsuit asks: Is PCAOB constitutional?

In a case that may wind up before the Supreme Court, a small Nevada CPA firm and an anti-tax group have lodged a legal challenge questioning the constitutionality of the Public Company Accounting Oversight Board.The Free Enterprise Fund, which filed the suit in Washington federal court in February, has teamed with Beckstead and Watts LLP, a one-partner firm in Las Vegas, in the litigation against the audit overseer.

The filing, in U.S. District Court here, charged that the PCAOB's structure violates the appointments clause of the Constitution. The five-member board is selected by the unanimous approval of the Securities and Exchange Commission, not by the president - which would require Senate approval - or by the courts or the department head of an agency.

The plaintiffs have the backing of the Competitive Enterprise Institute, a libertarian free-market think tank.

Hans Bader, counsel for special projects at CEI, published a paper in October titled, "The Public Company Accounting Oversight Board: An Unconstitutional Assault on Government Accountability." The paper said that the board is "responsible for a mountain of red tape," but specifically made a case that the board's structure and method of appointing members violates the appointments clause of the U.S. Constitution.

The appointments clause requires senior federal officials to be named by the president and confirmed by the U.S. Senate, while the president, the courts or a department head may pick lesser officers.

"The board has a high degree of confidence that it is constitutional, and it intends to vigorously assert that position. The board will defend its power to perform the duties it was assigned by Congress and President Bush," said a PCAOB spokesman.

When Congress created the five-member PCAOB in 2002, as part of the Sarbanes-Oxley Act, it established the board as a private, nonprofit corporation funded by corporate fees, leaving the appointment of board members to the Securities and Exchange Commission. Bader argued in his paper that the board members should be required to undergo Senate approval, but even if they are lower-level officials, the Constitution doesn't allow for their appointment through the five-member SEC.

The plaintiff's legal team includes Kenneth Starr, the special prosecutor in the Monica Lewinsky scandal, and former U.S. Assistant Attorney General for legal policy Viet Dinh.

The lead attorney is Michael Carvin, a partner at the Washington firm of Jones Day and a specialist in constitutional litigation. Carvin said that the PCAOB functions like a public entity via its decisions on policy and enforcement actions, yet has no oversight from the executive branch. As an example, he said that the president lacks the authority to hire or fire oversight board members. Two attorneys from the CEI will also represent the plaintiffs.

Beckstead and Watts was on the receiving end of critical inspection report from the oversight board, which sent a team of seven inspectors to examine some 16 audits performed by the firm, which had performed audits largely for micro-cap and development company clients.

In a report released in September, the PCAOB inspectors identified "deficiencies of such significance that it appeared to the inspection team that the firm did not obtain sufficient competent evidential matter to support its opinion on the issuers' financial statements."

In response to the preliminary report, Beckstead and Watts said that investors usually understand the high risk they are taking with any of the companies in the niche market, and also said that the majority of the audit clients that had going-concerns listed on their audit reports now were facing significant non-operating losses.

The firm wrote that it is a struggle "to perform audits in conformity with the requirements of SOX and the board working within the real cost constraints of our clients." While Beckstead stated that it disagreed with the findings of the board, the firm said that it has decided to reduce its client base to "just over ten."

Legal observers said that the suit might be a precursor to future legal efforts to mute SOX. The action comes at a time when myriad efforts are underway to roll back parts of SOX, particularly from the small business sector, which has voiced loud opposition to what it feels are unfair costs in money and human capital to comply with the sweeping reform act.

Recently, a cadre of financial heavyweights, including former SEC chair Arthur Levitt, former Federal Reserve chair Paul Volcker and former auditor general Charles Bowsher, sent a letter to SEC chair Christopher Cox asking that no public company - regardless of size - be exempted from SOX.

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